Wells Fargo Rebuke Puts Bank Boards in Fed's Crosshairs -- Update

The Federal Reserve's unprecedented move to handcuff growth at Wells Fargo & Co. sent a message that boards of directors, not just management, will be held accountable when big banks fail to manage risks.

The Fed on Friday said Wells Fargo would be replacing four board directors in 2018 and announced an enforcement action that limits the size of the third-largest U.S. bank by assets, potentially crimping revenue and profit growth.

While directed at Wells Fargo, which has struggled to overcome the sales practices scandal that engulfed the bank in September 2016, the Fed's action has wider ramifications.

"The Fed just put the fear of God into bank boardrooms across the country," Ian Katz, an analyst at Capital Alpha Partners, said in a note on Sunday. "And that's exactly what it wants to do."

The Fed, which cited "widespread consumer abuses" at Wells Fargo, has never before imposed such a broad restriction as part of an enforcement action. Wells Fargo is barred from growing past the $1.95 trillion in assets it had at the end of 2017, unless it gets regulators' permission. Fed officials did say the company can continue to lend and take deposits.

Wells Fargo said it was "confident it will satisfy the requirements of the consent order."

CEO Timothy Sloan, also a board director, said on a call with analysts Friday evening that the bank within 60 days will submit plans to the Fed "that leverage existing plans and efforts already under way to further enhance the board's effectiveness in carrying out its oversight and governance of the company and further improve the firm-wide compliance and operational risk management program."

A letter Friday from departing Fed Chairwoman Janet Yellen to Sen. Elizabeth Warren (D., Mass.), showed that the central bank is thinking more broadly than just Wells Fargo. Ms. Yellen wrote that the Fed is raising expectations for boards of directors across the banking industry.

The letter cited guidance for boards the Fed proposed in August, which Mrs. Yellen wrote "marks the first time that the Federal Reserve has issued stand-alone expectations for boards of directors as distinct from management."

"That distinction allows us to spotlight the core responsibilities of effective boards, one of which is to ensure the independence and stature of the risk management and internal audit function," the letter said.

Mrs. Yellen handed over leadership of the central bank this weekend to Jerome Powell. He was appointed by President Donald Trump, who has pushed a deregulatory agenda for banks and other industries.

But banks shouldn't necessarily think Mr. Powell will change course. As a Fed governor, he took a leading role in pushing the Fed to adopt the new regulatory guidance for board members.

"Across a range of responsibilities, we simply expect much more of boards of directors than ever before," Mr. Powell said in an August 2017 speech, the month the draft guidance was published. "There is no reason to expect that to change."

The Fed guidance, which applies to all banks, seeks to reduce the number of regulatory requirements for which boards of directors are directly accountable. Fed officials said the goal wasn't to make boards' lives easier but to push the board to focus on big-picture issues, such as firm-wide risk management.

The restriction on Wells Fargo's asset growth also took the Fed into uncharted territory, and the harsh penalty reflected a judgment that the bank's board failed to ensure "that senior management had established and maintained an adequate risk management framework commensurate with the size and complexity of the firm," as the Fed's enforcement order put it.

During the financial crisis, the Fed and other banking regulators indirectly pushed banks to add board directors with more financial experience.

Wells Fargo had been an outlier in recent years among big banks, expanding its footprint at a time when peers such as Citigroup Inc. and Bank of America Corp. were largely retrenching as they recovered from the 2008 financial crisis. For instance, regulators didn't object to Wells Fargo acquiring or financing nearly $50 billion of General Electric Co.'s assets as it dismantled its GE Capital lending unit around 2015.

More recently, as the bank's problems in different corners of the firm continued to unfold, Fed officials concluded Wells Fargo had grown and taken on more risk, without adequately updating its ability to manage that risk. The firm's problems were so broad that officials decided a broad punishment was warranted.

In September 2016, the bank settled allegations that it had engaged in years of improper sales practices that resulted in potentially 3.5 million accounts being opened without customers' knowledge. Elsewhere, more than 550,000 auto-loan and mortgage customers were possibly overcharged for products for years as well.

Over the past year, and even before the Fed's action, Wells Fargo had named six new directors, including three who joined in January 2018. Three of Wells Fargo's current directors were planning to retire by the end of the bank's annual shareholders meeting, which typically occurs in late April, a person familiar with the matter had said before the Fed penalty was announced Friday.

Ms. Yellen said last fall the Fed was committed to taking action against Wells Fargo, and negotiations on the terms intensified during the past several weeks, people familiar with the matter said. The main sticking points were the asset cap, the terms for which the asset cap would be removed and the letter to Wells Fargo's board of directors, these people said.

Write to Ryan Tracy at ryan.tracy@wsj.com and Emily Glazer at emily.glazer@wsj.com